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September
16, 2003, 8:15 a.m.
As Inventories Rise . . .
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. . so will jobs and the economy.
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any financial markets have begun to reflect the economy’s move from deflation
to reflation. However, the economic strength of the reflation process
is still being underestimated.
Businesses
are rebuilding inventories, which will cause industrial production to accelerate,
capacity utilization to rise, and employment to grow. This should raise
economic growth expectations from “moderate” to “fast.” And at some point
along the way, the Federal Reserve will signal that it's going to hike rates,
and then it will carry out those hikes — lifting the fed funds interest
rate to 3 percent (it's now at 1 percent) sooner than the market now expects.
No one knows very
much about deflation or reflation. The U.S. has never gone through either
state while under a floating exchange-rate regime. And the U.S. broke
away from the only other occurrence — Japan’s deflation experience
of the 1990s — with the Fed’s quantitative easing after 9/11, the
dollar’s 2002 reversion to a non-deflationary level, and the president's
strongly stimulative tax cut this year.
Though it is popular
to blame China for U.S. job losses, the data shows clearly that the ongoing
U.S. inventory reduction — a vestige of deflation and a sign of risk
aversion - drove the weakness in manufacturing, capacity utilization,
and manufacturing jobs. As inventories rise, the perception of the U.S.
economy and its competitiveness should improve quickly.
A number of indicators
will soon begin to show (and are already starting to show) the extent
of the reflationary acceleration of the U.S. economy, pushing growth estimates
above 5 percent, from below 4 percent. Gold prices have already
risen. Commodity prices are catching up. Equities and bond yields have
risen. And the risk spread (or difference) between Treasury bills and
corporate bonds has narrowed.
Consumer demand
in July and August accelerated from the strong 4 percent annualized second-quarter
growth rate. Retail sales for August were “below expectations” only because
a small sample of auto receipts reported slow growth in early August.
The more solid piece of data — the actual number of autos sold as
reported by the auto companies — was up 9.6 percent in August. This
is the measure used in calculating third-quarter gross domestic product.
Retail sales excluding gasoline grew 13 percent at an annual rate in the
last six months.
The drawdown in
inventories has been part of the drag on manufacturing production. With
demand growing strongly, inventories will rebuild, causing manufacturing
production to grow. And this increase in manufacturing production will
soon contribute to employment gains. The loss of manufacturing jobs since
the February 2001 employment peak accounted for almost all the total job
losses, making manufacturing jobs a key variable in near-term job growth.
The concerns currently
expressed in the financial markets — and also at the Fed — over
a jobless recovery and excess capacity seem misplaced and could evaporate
quickly as inventory rebuilding kicks in.
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